The Post-Crisis Global Economy Will Be Characterized By Large Imbalances

Many analysts and observers believe that the global imbalances
that characterized the world economy in the years before the 2008
crisis have substantially dissipated.

But, while it is true that China’s current-account surpluses and
America’s deficits have somewhat moderated since then, have the
imbalances really been corrected?

More important, can the post-crisis global economy enjoy both
growth and balance?

To answer these questions, it is important to understand the
imbalances’ underlying dynamics. An economy’s current account is
the difference between its investment rate and its savings rate.

In 2007, the United States had a savings rate of 14.6% of GDP,
but an investment rate of 19.6%, generating a current-account
deficit. By contrast, China had a fixed investment rate of 41.7%
of GDP and a savings rate of 51.9%, reflected in a large surplus.

Since 2007, the US current-account deficit has narrowed, but not
because of a higher savings rate. Rather, the external deficit
has been squeezed by a collapse in investment activity, while
America’s overall savings rate has fallen below 13% of GDP, owing
to worsening government finances.

Meanwhile, China’s savings rate remains stubbornly high. The
surplus has narrowed because investment has been ramped up even
higher, to roughly 49% of GDP. In other words, the Americans save
even less today than they did before the crisis erupted, and the
Chinese invest even more.

Any future recovery in the US economy will almost certainly
trigger a revival in investment activity. American businesses
have postponed much-needed capital spending and, with American
airports and bridges in appalling condition by developed-country
standards, investment in infrastructure is crucial as well.

Indeed, it
is very likely that reviving growth will lead to larger
current-account deficits, even if the savings rate improves and
domestic energy production curtails oil and gas imports.

China has the opposite problem. In order to sustain growth, it
needs to continue to invest half of its $9 trillion annual GDP –
no easy task for a country that already has brand new highways
and airports.

In fact, over the next decade, as China attempts to move up the
value chain into services and adjusts to a shrinking workforce,
its investment requirements will shrink – and its investment rate
will fall sharply.

Of course, China’s savings rate will also decline, but Japan’s
experience since the 1980’s demonstrates how a sharp fall in
investment can generate large and persistent current-account
surpluses, even when the savings rate is falling and the currency
is appreciating. Indeed, a stronger currency can paradoxically
feed external surpluses, while discouraging investment in
export-oriented industries.

The implication is that the post-crisis global economy will not
be characterized by balance, but by a return to large
macroeconomic imbalances. But, although many economists will
consider this problematic, history shows that symbiotic
imbalances have characterized virtually all periods of global
economic expansion.

The Roman Empire ran a persistent trade deficit with India for
centuries. Although the resulting outflow of gold caused monetary
debasement in the Roman Empire, Indo-Roman trade remained the
backbone of the global economy.

Similarly, Spain ran persistent deficits in the sixteenth and
seventeenth centuries, paid for by Andean silver. The resulting
flood of liquidity caused a global boom that benefited economies
from Elizabethan England to Mughal India. And 1870-1913, another
period of rapid growth and globalization, was not characterized
by balance; it was funded by the United Kingdom, acting as the
world’s “bank.”

In the last 60 years, the US has underpinned global growth by
running persistent current-account deficits. Under the Bretton
Woods system, the US ran deficits that enabled war-torn Europe
and Japan to rebuild. In return, Europe funded the US deficits.

The system broke down when European countries, particularly
France, decided to stop funding those deficits. But the economic
model persisted, with Asian economies stepping in to finance the
US deficits, while using the US market to grow rapidly. China is
the latest and largest beneficiary of the economic model dubbed
“Bretton Woods II.”

Clearly, periods of global growth are almost always characterized
by symbiotic imbalances. But, while each of these episodes was
characterized by macroeconomic distortions caused by the
imbalances, they lasted for years, or even decades. So, the real
question is what the next generation of symbiotic imbalances will
look like.

It is likely that China will soon return to running very large
current-account surpluses – potentially large enough to fund the
US, with plenty left over for the rest of the world. As this
capital cascades through the global financial system, it will
re-inflate the economy.

In the “Bretton Woods III” system, China will transform from
“factory to the world” to “investor to the world.” Like all
imbalanced systems, it will have its distortions, but the
arrangement could last for many years.

This article was originally published by Project Syndicate. For more from Project Syndicate, visit their new Web site, and follow them on Twitter orFacebook.